“The typical view is that an economy in a deep recession is in no danger of price inflation. This belief is wrong both in theory and in practice. The classic explanation of price inflation is too much money chasing too few goods. During recessions in the postwar period, the Fed typically opens the monetary spigots at the same time that the output of goods and services is falling. Therefore, other things being equal, we would expect inflation to go up during recessions.

The historical data are generally consistent with this conclusion. The worst bout of inflation during the postwar period occurred during the economic slump of the late 1970s and early 1980s. More recently, consider that in 2006, the inflation rate was slightly lower than last year’s figure even though the unemployment rate in 2006 was only half of the average for 2009.”

With the Obama administration support for building new nuclear plants, we have finally resolved the roadblock to developing nuclear power for electricity. Hopefully this will allow the US economy to develop and build a significant capacity in nuclear power to supply long term affordable electricity.

“Inflation-fuelled debt is encouraged by deductibility of interest in assessing corporate tax. High returns to leveraged capital helped create the over-sized finance sector that became a breeding ground for the financial crisis. Periodic deflation would reverse that asymmetric bias. It need not spiral downward. Recent experience shows that deflation can be controlled by monetary and fiscal policies. Stimuli should focus on income-producing investment, not consumption.”

Many (including me) believe that large increases in US federal spending will result in the next two years in accelerating inflation and a downward drift in the value of the US dollar. Inflation will be seen in the rise of commodity prices more rapidly than other products. To protect your finances from inflation, it will be attractive to purchase assets.

The dollar should fall against other currencies as the economy stabilizes. This may not be as dramatic as the pickup in inflation because the other major currencies are also weak. All major currencies will weaken as measured in commodity prices. The value of the dollar may not decline as much since the other currencies will be inflated as well.

From a business standpoint, this weakening of the dollar and increase in commodity prices is an opportunity for steel casting producers. It suggests two approaches to profit. Steel foundries should prepare for strong demand from commodity producers, mines and energy, and prepare to exploit export markets.

If the dollar weakens while commodity prices rise, then US produced steel castings will be in demand and cost competitive around the world. The weak dollar/strong commodity prices prior to the current financial crisis created some export demand especially to Europe. Once economic conditions are stable and credits flows, many prior capital projects globally will be attractive. We need to develop the infrastructure necessary to profit from this trend.

One method of profiting from the global casting demand will be to supply global corporations. Globalization is not multinational but shifted to become truly global. Instead of regional business affiliated in the old multinational model of business, globalization has created global supply chains. When the dollar was strong and demand weak, this was a threat as offshore competitors sought to gain market access and take our business. In a weak dollar/strong commodity prices boom, the tables will turn and we will be the ones with global opportunities.

Most economists, including yours truly, have been saying that the huge budget deficits the country is running will result in inflation. So, where’s the inflation? Inflation normally lags changes in the growth of the money supply by one to two years. The big monetary expansion took place in the last half of 2008. So if the economy follows past trends, one would expect to see growing inflation by the latter part of this year.

There are several reasons why inflation does not occur simultaneously with a sudden growth in the money supply. (Remember, inflation is caused by the money supply growing faster than the supply of goods and services.) The Fed greatly expands the money supply when it sees the economy is entering a recession in order to temporarily reduce interest rates and increase the supply of loanable funds. But a recession is a decline in business activity. When business declines because of a fall in demand, the normal reaction of businesspeople is to cut prices (deflation) to reduce excess inventories.

It appears that the inventory-reduction portion of the business cycle is over, and the data show that most businesses have begun to rebuild inventories. This inventory rebuilding is increasing the demand for basic commodities, but the rise in commodity prices has not yet overcome the big productivity gains the U.S. has experienced over the past three quarters.

When an economy goes into a recession, there normally is a fall in labor productivity because employers are reluctant to lay off workers, and hence, most businesses find themselves overstaffed, which means that output per hour of work declines. Employers eventually are forced to cut staff, and the workers who are let go usually are the least productive ones. When there are enough workers to meet demand for the product, but not an excess of workers, productivity normally shoots up because the more productive workers (and more motivated ones) are the ones who have kept their jobs. The increase in productivity means goods and services can be produced at lower costs, and this effect masks the monetary inflation.

When inflation rises (or is expected to rise), interest rates rise – except during the early stages of the business cycle, when there is a paradoxical result of larger government deficits being most often associated with lower interest rates. The noted economist John H. Makin explained this effect very well in a recent American Enterprise Institute paper in which he wrote: “in the United States, nonfederal government debt (currently about $27 trillion) is nearly four times as large as federal government debt (currently about $7.2 trillion). When the economy enters a recession, countercyclical fiscal policy boosts deficits and government debt while private debt falls. Given that the stock of private debt is so much larger than government debt, the drop in private borrowing in a recession overwhelms the impact on total borrowing of a rise in government deficits.”

But alas, all of this is temporary. As the economy begins to recover, both business and individual borrowing increases, putting upward pressure on interest rates. Government borrowing merely accelerates the rise in real, inflation-adjusted interest rates. The higher interest rates go, the more costly it is for consumers to buy new homes, automobiles and other items they normally buy on credit and the more costly it is for businesses to borrow for new plants and equipment. These interest-rate increases begin to choke off demand for consumer durables and business plants and equipment, which slows down or even reverses economic growth.

The Federal Reserve and other central banks around the world can mask the rise in interest rates for awhile, as they are now, by making money available to the banks at very low rates (presently close to zero for short-term borrowing). And individuals and businesses can squirrel away much of the new money by increasing their savings rates. But what happens if people see a rise in inflation and at the same time are unable to obtain sufficiently high interest rates on their savings to cover the inflation and then some? Many increasingly will flee from holding cash balances and just buy “stuff,” which can lead to an accelerating rate of inflation or even hyperinflation.

Or, as has happened in Japan, the people see the government accumulating so much debt that they don’t believe the government will be able to fulfill its promises for the Japanese equivalent of Social Security and Medicare, so they hoard cash in a belief that they will need it for their retirement. A rising savings rate means lower consumption with little or no inflation, or even deflation, leading eventually to economic stagnation, which is what the Japanese have.

Studies show that once the government ratio of debt to gross domestic product rises above 90 percent, interest rates begin to accelerate to destructive levels. The debt projections by the administration and the Congressional Budget Office show the U.S. getting very close to such a level in the next few years, while more objective private forecasters see the debt-GDP ratio rising to much more than 100 percent.

The alternatives are simple – greatly reduce the growth in government spending or suffer a huge rise in inflation and/or economic stagnation. (Increasing tax rates, which already are at high levels, slows economic growth and job creation, which in turn increases the demand for government services and payments – and hence becomes more of a problem than solution.) Who, among our politicians, has actually produced a real plan to reduce the growth in government spending to the necessary levels?

Richard W. Rahn is a senior fellow at the Cato Institute and chairman of the Institute for Global Economic Growth.

I'm the executive vice president for a steel casting trade association, the Steel Founders' Society of America.
I've got a crazy wife, five crazy children, three crazy people that married into the family, and two crazy fun little grandsons.